November Model Shadow Stock Portfolio Update

The Model Shadow Stock Portfolio bounced back during October, gaining 5.7% for the month. While small-cap stocks lagged larger companies during the month, analysts note that smaller companies have typically outperformed larger firms during periods of rising rates of inflation. Analysts surmise that the nimble nature of smaller firms allows them to more easily adapt to inflationary pressures and raise prices more easily than larger firms.

Interest in small-cap stocks has been growing lately as their valuations look more attractive compared to large-company stocks. Small-cap stocks are also benefiting from stronger year-over-year increases in earnings compared to larger firms.

The S&P 500 index has a trailing price-earnings ratio of 27.1, while the S&P SmallCap 600 index has a trailing price-earnings ratio of 34.9. The trailing price-earnings ratio uses the reported earnings over the latest 12 months for its denominator. The forward price-earnings ratio uses the expected earnings over the coming year as its denominator. The S&P 500 forward price-earnings ratio drops to 21.6 compared to its trailing price-earnings ratio of 27.1, but for the SmallCap 600, the forward price-earnings ratio is 16.1 compared to its trailing price-earnings ratio of 34.9.

The S&P 500, as measured by the Vanguard S&P 500 Index fund (VFINX), was up 7.0% during October, and is up 23.9% for the year. As we noted, the Model Shadow Stock Portfolio gained 5.7% during October, boosting its year-to-date return to 43.2%. The Vanguard Small-Cap Index fund (NAESX) was up 4.9% during the month and is reporting an 18.8% gain during 2021, while the DFA U.S. Micro-Cap fund (DFSCX) gained 4.4% during October and is up 29.9% for the year.

All of the sectors were in the green during October, with consumer discretionary leading all segments with a 12.0% gain. Other strong sectors included energy (up 10.3%) and technology (up 8.2%). Communication services was the weakest sector during the month, posting a 0.2% gain, followed by consumer staples (up 3.5%) and utilities (up 4.7%). The energy sector is the strongest-performing sector during 2021 with a 56.9% gain during the first 10 months of the year. Financials are the second-strongest sector for the year with a 38.6% gain, and real estate is in third place with a gain of 33.8% year to date. Consumer staples is the weakest sector for the year, up 7.6% year to date, followed by utilities (up 9.1%) and materials (up 19.0%).

In a reversal of fortunes, growth stocks posted gains during October, fueled by the technology rally during the month. In contrast, value stocks showed losses across all market capitalization sectors during October.

In the large-cap segment, growth stocks were up 9.1% during October, giving them a 27.0% gain year to date for 2021. Large-cap value stocks were up 4.6% during October and are up 20.6% year to date.

In the mid-cap segment, growth stocks are up 18.4% for the year, after gaining 7.6% during October. Mid-cap value stocks are up 26.4% for the year, after gaining 4.4% during the month.

Small-cap growth stocks are up 7.6% during the year, while small-cap value stocks are up 27.6%. Small-cap growth stocks gained 4.7% during October, while small-cap value stocks gained 3.8% during the month.

Since its inception in 1993, the AAII Model Shadow Stock Portfolio has a compound annual average return of 15.2% versus the Vanguard 500 Index fund’s gain of 10.5% per year on average over the same period. Over the same period, the Vanguard Small-Cap Index fund posted an average annual gain of 10.7%.

Monthly Observations

Twenty-six stocks met the initial selection criteria for the Model Shadow Stock Portfolio as of November 12, 2021, down from 30 passing stocks one month ago. AAII members can see and research which companies are currently passing the initial selection criteria in the Shadow Stock Ideas table on AAII.com. The list of Shadow Stock Ideas is updated daily—Tuesday through Saturday.

Of the 26 qualifying companies, seven are currently held in the Model Shadow Stock tracking portfolio: Hurco Companies Inc. (HURC), Key Tronic Corp. (KTCC), Mesa Air Group (MESA), Pangaea Logistics Solutions Ltd. (PANL), SIFCO Industries Inc. (SIF), Strattec Security Corp. (STRT) and VOXX International Corp (VOXX). No additional stocks held in the Model Shadow Stock Portfolio were added to the current list of qualifying stocks.

Ampco-Pittsburgh Corp. (AP) came off the qualifying list when its price-to-book-value ratio went above 1.10. The stock was trading with price-to-book value ratio of 1.18 as of November 12, 2021. Orion Group Holdings Inc. (ORN) came off the list of qualifying stocks when it reported negative quarterly earnings that also pushed its trailing 12 month earnings per share into the red. Orion Group is a specialty construction company, which serves the infrastructure, industrial and building sectors with a focus on the marine area. Its results were hurt by continued logistics issues related to the coronavirus pandemic, exacerbated by impact of the strong hurricane season. Orion Group’s backlog continues to grow, but negative earnings placed Orion Group on earnings probation. If it reports quarterly negative adjusted earnings prior to 12-month adjusted earnings becoming positive, the stock will be sold at the next quarterly review. You can read more about Orion Group’s earnings report below.

Rayonier Advanced Materials Inc. (RYAM) was also placed on earnings probation after it reported a loss for the quarter. Rayonier Advanced Materials is a leading global supplier of high purity cellulose specialties products, a natural polymer for the chemical industry. The company’s operations were hurt by higher supply and energy costs. Demand for its products remains strong but will take some time to raise prices due to contract constraints.

As of November 12, 2021, Perion Network Ltd. (PERI) had the highest price-to-book ratio in the Model Shadow Stock Portfolio. Its ratio of 3.78 is now more than three times the 1.10 maximum value used for initially qualifying a stock for inclusion to the portfolio. Big 5 Sporting Goods Corp.’s (BGFV) price-to-book value ratio of 3.44 is also more than three times the current 1.10 initial maximum. Shadow stocks with a price-to-book ratio three times the initial maximum (1.10 × 3 = 3.30) at the time of a quarterly review are removed from the portfolio, assuming there is a suitable replacement. Perion Network is an Israel-based global technology company that delivers online advertising solutions and search monetization to brands and publishers. Perion Network was the top-performing stock in the portfolio for the month of October, up 64.0%. Big 5 Sporting Goods is a sporting goods retailer in the western U.S. Its stock price was up 4.9% during October, but it also gained 82.5% for the month through November 12, 2021.

Ranger Oil Corp. (ROCC) has the highest market-cap value of $1,396.4 million as of November 12. Ranger Oil, formerly Penn Virginia Corp., is an independent oil and gas company. The company is engaged in the development and production of oil, natural gas liquids (NGLs) and natural gas, with operations in the Eagle Ford shale in South Texas. The Model Shadow Stock Portfolio looks for stocks with a market cap (share price times shares outstanding) greater than $30 million but less than $500 million when adding stocks to the portfolio. Shadow stocks with a market cap three times the initial market cap maximum ($500 million × 3 = $1,500 million) at the time of a quarterly review are sold from the portfolio, assuming there is a suitable replacement.

The initial market cap and price-to-book levels are adjusted over time to reflect the changing market conditions.

Next Portfolio Review

The next quarterly review of the Model Shadow Stock Portfolio will take place following the end of November 2021. Any changes to the portfolio will be announced at the time they are made in our Model Shadow Stock Portfolio Update emails (sign up at www.aaii.com/email).

Model Shadow Stock Portfolio News

Perion Network Ltd. (PERI) was the top-performing stock in the portfolio for the month of October, up 64.0%. The company reported earnings for the third quarter of 2021 during the month. Read more about Perion Network’s earnings below.

Ranger Oil Corp. (ROCC) was the second-best performer in the portfolio for October, up 23.9%. The company has benefited from a resurgence in oil prices from 2020. During the month, the company completed an acquisition and rebranded the company from Penn Virginia Corp. to Ranger Oil Corp. Read more about Ranger Oil below.

Orion Group Holdings Inc. (ORN) was the bottom performer in the portfolio, declining by 18.2% for the month. The company reported losses in both earnings and operating income during October. Read more about Orion Group’s earnings report below.

Ultralife Corp. (ULBI) was the second-worst-performing stock in the portfolio for October, down 12.1%. During the month, Ultralife reported its third-quarter 2021 results. The company missed on earnings estimates and saw a decline in sales year over year. Read more about Ultralife’s third-quarter results below.

Here are some news highlights from October for the holdings in the Model Shadow Stock Portfolio:

Bassett Furniture Industries Inc. (BSET) declared a regular quarterly dividend of $0.14 per share, in line with the previous declaration. The dividend is payable on November 26 to shareholders of record as of November 12.

Covenant Logistics Group Inc. (CVLG) announced its third-quarter 2021 earnings of $1.02 per share, in line with the I/B/E/S consensus estimate. Earnings per share increased year over year by 82.1%. Sales revenue totaled $274.6 million for the quarter, up by 30.2% year over year.

Total revenue in the truckload operations segment increased by 12.9% year over year to $168.8 million. The increase in freight revenue was primarily related to a 14.2% increase in average freight revenue per truck, offset by a 6.2% decrease in the average operating fleet size that has resulted from the constraints of an extremely tight driver market. For the quarter, the managed freight segment’s freight revenue increased by 89.2% year over year to $90.1 million.

“We were pleased to report third-quarter earnings of $0.97 per share and non-GAAP adjusted earnings of $1.02 per share, the highest earnings for any quarter in the company’s history,” said chairman and CEO David Parker. “Based on our current run-rate, we expect to generate over $1 billion in revenue and the highest annual earnings per share in our history during 2021. Despite these achievements, we remain focused on further improving our profitability, particularly in our dedicated segment, which fell short of our expectations for the quarter.”

Looking forward, Covenant Logistics said potential headwinds include inefficiencies from reengineering or replacing certain contracts, driver availability and cost, accident experience, the cost and volatility of claims, general inflation and supply and demand factors for our customers and our industry.

Mesa Air Group (MESA) signed an agreement with Flirtey to order four delivery drones with an option to order 500 additional aircraft. This contract makes Mesa Air Group the first scheduled airline to launch drone delivery in the U.S.

“Mesa is excited to partner with Flirtey to become the first scheduled airline to launch drone delivery in the U.S. Drone delivery is a huge market and it’s here now,” said chairman and CEO Jonathan Ornstein. This is the future of small package last-mile delivery.”

Orion Group Holdings Inc. (ORN) announced a third-quarter 2021 adjusted loss of $0.27 per share, which compared year over year to earnings of $0.23 per share. Orion Group missed the I/B/E/S consensus estimate for a loss per share of $0.13. Sales revenue totaled $139.9 million for the quarter, down 26.1% year over year.

The decrease in revenue was primarily driven by the timing and mix of several large marine projects that had driven activity in 2020, which were not replicated or replaced in the third quarter of 2021. This decrease was partially offset by increased production volumes in the concrete segment due to an increase in activity during 2021, including on several larger jobs in the current-year period as compared to the prior-year period.

“Our third-quarter results were impacted by lower-than-anticipated revenue due to the phasing of project work, project win rates and timing, tropical weather and COVID-19 related items,” said CEO Mark Stauffer. “This also resulted in an increase in unabsorbed labor and equipment, which further pressured margins.”

Looking forward, Orion Group reported an increase in its backlog of work contracts year over year by 33.6% to $572.8 million. The company said that its bidding activity remains healthy and that it continues to see demand for its services.

Ranger Oil Corp. (ROCC), formerly Penn Virginia Corp., closed the acquisition of Lonestar Resources US Inc. The company began trading under its new name and ticker, ROCC, on October 18. The rebrand will be fully complete before year-end 2021.

Perion Network Ltd. (PERI) reported third-quarter revenues of $121 million, up 45.1% from $83.4 million in the prior-year quarter. The company had earnings of $0.28 per share, beating the I/B/E/S consensus estimate of $0.175 per share by 60%.

Non-GAAP net income for the quarter saw a 159% increase to $15.4 million compared to $5.9 million in the third quarter of 2020. The company’s cash flow from operations also enjoyed a pickup, increasing by 115% year over year from $14.2 million to $6.6 million.

“During the first nine months of the year our display advertising generated more than $165 million of revenues, exceeding the $149 million generated for all of 2020,” said CEO Doron Gerstel. “Driven by the capabilities of our iHub to create unprecedented advertising efficiencies, our average deal size expanded by 30%, as budgets moved to our breakthrough high-impact, creatively led formats especially for video and CTV. In recognition of the growing demand for video advertising, we made the accretive acquisition of Vidazoo, a leading video tech platform.”

Management expects to generate revenues of $455 million to $465 million for fiscal-year 2021. The company expects to see revenues in the range of $580 million to $600 million in 2022, a projected 28% year-over-year growth.

Strattec Security Corp. (STRT) reported first-quarter fiscal-2022 revenue of $100.3 million, down 20.5% from $126.2 million in the first quarter of fiscal 2021. Sales decreased primarily due to lower vehicle production volumes for which Strattec Security supplies components, an effect of the continuing global semiconductor chip shortage.

Net income was $0.1 million in the current-year quarter, down 98.8% compared to a net income of $8.0 million in the prior-year quarter. Diluted earnings per share were $0.88, missing the I/B/E/S consensus estimate of $1.04 per share by 15.4%.

“This has been a very challenging quarter,” said CEO Frank Krejci. “For example, industry vehicle build rates in September 2021 were 34% below those in April 2021 due to supply chain issues, forcing many temporary assembly plant closures by our customers during the current quarter. There has been some recent improvement in supply chain issues, a trend that will hopefully continue. Longer-term, reasons for optimism remain because of continued consumer demand, extremely thin industry inventory levels and recent reductions of assembly plant closures.”

Strattec Security did not give guidance on the full year of 2022, but I/B/E/S analysts currently estimate the company to earn $3.95 per share in 2022.

Titan Machinery Inc. (TITN) announced the acquisition of Jaycox Implement. Over the trailing 12 months, Jaycox generated around $91 million in revenues. Titan Machinery expects the acquisition to be immediately accretive to earnings per share, and to fully close in December 2021. The full details of the terms have not fully been disclosed.

Ultralife Corp. (ULBI) reported a third-quarter 2021 loss per share of $0.04, down year over year from earnings of $0.04 per share in the same period of 2020. Earnings missed the I/B/E/S consensus estimate of $0.08 per share by 150%. Net sales totaled $21.8 million, a 10.7% decline.

Operating income for the quarter was $0.7 million, a 200% decrease over $0.7 million reported in the third quarter of 2020. Gross profit was $5.1 million, compared to $6.5 million in the same 2020 quarter. Net income also decreased 250% year over year, from $0.4 million to a loss of $0.6 million.

“Supply chain bottlenecks intensified during the third quarter, which extended both our own and our customers’ product manufacturing schedules and delayed shipments, thereby impacting third-quarter revenue and earnings,” said CEO Michael Popielec. “The 11% year-over-year decrease in revenue, primarily related to the government/defense sector, masked a 5% increase in commercial sales led by a continued rebound in oil and gas revenue and our new ER and thin cell products. Medical sales grew 11% sequentially over the second quarter reflecting the continued solid demand for our products.”

While the company did not give any guidance for the full fiscal year of 2021, I/B/E/S estimates are currently projecting earnings per share of $0.31.

VOXX International Corp. (VOXX) reported fiscal second-quarter 2022 earnings per share of $0.23, beating the I/B/E/S consensus estimate of $0.07 per share by 228%. The company reported $0.30 earnings per share in the comparable period of fiscal 2021.

VOXX had net sales of $143.1 million for the quarter, up 11.8% from the same quarter of 2021. The company reported gross income of $37.2 million, down 2.1% from the second quarter of 2021. Net income for the quarter was $0.3 million, down 95.9%.

“The VOXX team has done a good job navigating through what we believe was the worst of the supply chain shortfalls and we have the inventory on hand or in transit, to deliver for our customers,” said president and CEO Pat Lavelle. “Excluding professional fees related to transactions which are now complete, our operations performed slightly better than the first half of fiscal 2021, with adjusted EBITDA [earnings before interest, taxes, depreciation and amortization] up $3.9 million. We expect growth will continue in the second half of the year and to be up approximately 15% for the full fiscal year. We also expect good bottom-line performance, with extra investments in R&D [research & development] to support new automotive OEM [original equipment manufacturer] programs and future EyeLock business.”

While the company did not give any guidance for the full year of 2022, I/B/E/S estimates are currently projecting earnings per share of $0.77.

VSE Corp. (VSEC) reported third-quarter 2021 adjusted earnings per share of $0.76. Earnings beat the I/B/E/S consensus estimate of $0.73 per share by 4.0%. Net sales for the quarter totaled $200.6 million, a 21.2% increase over the same period of 2020, which saw net sales of $165.5 million.

The company reported net income of $9.0 million, an 11.1% increase over the same period of 2020. Gross income for the quarter was $19.6 million, a 2.1% increase over the second quarter of 2020. The aerospace industry is beginning to recover from the pandemic; however, supply chain issues within the electrical components industry still present a major hurdle for manufacturers.

“We continued to execute on our aftermarket distribution and MRO [maintenance, repair and operations] strategies during the third quarter, while positioning the business to generate above-market revenue growth in higher-margin, niche verticals that leverage our unique value proposition,” said president and CEO John Cuomo. “We remain focused on growing the business both organically and inorganically and are pleased with the early progress made with the recently completed Global Parts acquisition. We continue to stay focused on achieving our net leverage target of 2.5x by year-end 2022 through meaningful growth in EBITDA as a result of the recent investments in working capital made throughout 2021.”

Guidance for the rest of fiscal-year 2021 was not given, but I/B/E/S analysts estimate the company to have full-year adjusted earnings per share of $2.59.